Escalating Long-Term Interest Rates Jeopardize the U.S. Economy’s Hopes for a ‘Soft Landing’

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Soaring long-term interest rates are exacerbating the difficulties confronting the U.S. economy, potentially undermining the Federal Reserve’s objective to control inflation without precipitating a severe recession.

Starting from mid-summer, the yield on the 10-year U.S. Treasury note, a key indicator for various loan rates, has been on a consistent uptrend. This has resulted in a ripple effect on other forms of borrowing. Mortgage rates, auto loan costs, and credit card interest rates have all ascended correspondingly, putting additional strain on households as well as the federal government’s fiscal health.

The spike in long-term interest rates is occurring in tandem with several other economic headwinds, including inflated gasoline prices, the recommencement of federal student loan repayments, an ongoing strike by United Auto Workers, and the looming possibility of a government shutdown. These factors collectively reduce consumer disposable income, thereby attenuating the driving force of the economy.

Now into its third week, the United Auto Workers’ strike shows no signs of a swift resolution, posing a threat to vehicle sales in the upcoming months. The situation is further complicated by political tumult, particularly the recent ousting of House Republican leader Kevin McCarthy due to his collaboration with Democrats to avert an immediate government shutdown.

After experiencing a vibrant summer characterized by robust consumer expenditures on travel and entertainment, the U.S. economy is estimated to have expanded at an annualized rate of 3.5% in the third quarter, according to Goldman Sachs economists. However, projections indicate a slowdown to a modest 0.7% growth rate in the last quarter of the year. High borrowing costs and lingering inflation are prompting consumers—who account for approximately 70% of economic growth—to exercise increased financial caution.

The upcoming September jobs report, slated for release this Friday, will offer insights into how employers are adapting to the current economic landscape. Economists predict that the report will indicate the addition of 162,000 jobs last month and a slight decline in unemployment rates to 3.7%, close to a 50-year low.

Nevertheless, the significant increase in borrowing costs could exacerbate the economy’s deceleration. On Tuesday, the 10-year Treasury yield reached a 16-year peak of 4.8%, a sharp rise from 3.3% in April. According to Freddie Mac, the average 30-year fixed mortgage rate last week stood at 7.3%, marking the highest level in nearly a quarter-century.

Loretta Mester, President of the Federal Reserve Bank of Cleveland, indicated that the uptick in long-term interest rates will be a consideration in the Federal Reserve’s forthcoming policy decisions, hinting that it may deter them from implementing another rate hike by the end of the year.

Financial experts attribute the rapid rise in lending rates to several factors, including the Federal Reserve’s commitment to maintaining elevated key rates for a prolonged period, exceeding market expectations. Moreover, the continued economic growth despite increased rates has created the perception that the economy can bear higher borrowing costs.

Unlike the period following the 2008-2009 financial crisis, when rates were slashed to near-zero levels, the current economic resilience may signify enduringly high borrowing costs. The Treasury Department is also issuing more debt to finance an escalating budget deficit, projected to reach $1.5 trillion this year and expected to further rise in 2024. This is happening concurrently with the Fed’s reduction of bond holdings and decreased purchases by international buyers, which adds upward pressure on rates.

Benson Durham, previously an economist at the Fed and now head of global policy at Piper Sandler, posited that the volatile and uncertain economic backdrop makes holding long-term government debt increasingly risky, thereby contributing to rising rates.

Moreover, Federal Reserve officials have transitioned from a clear rate-hiking trajectory to a more ambiguous position. Fed Chair Jerome Powell has emphasized a “data-dependent” strategy, suggesting that future rate hikes will only occur if substantiated by prevailing economic data.

Other factors, such as the resumption of student loan payments and higher fuel costs, are also expected to erode economic growth. Goldman Sachs estimates that these will reduce annual growth by 0.5 and 0.3 percentage points, respectively, in the final quarter of this year and the first quarter of the next.

Should a government shutdown materialize next month, it would result in an additional 0.2 percentage point contraction in growth for each week it persists, according to Nancy Vanden Houten, an economist at Oxford Economics.

David Page, head of macro research at AXA IM, anticipates a dramatic shift in economic sentiment by the end of the year, where the expectation of a “soft landing” will be supplanted by renewed concerns of a recession.

Frequently Asked Questions (FAQs) about Long-Term Interest Rates

More about Long-Term Interest Rates

• Federal Reserve Policy Updates
• Goldman Sachs Economic Forecasts
• U.S. Treasury Yield Data
• Impact of United Auto Workers Strike
• Government Shutdown Implications
• Inflation Trends in the U.S.
• Oxford Economics Research Reports
• Borrowing Costs and Consumer Debt
• Current Gas Prices and Economic Impact
• Student Loan Repayments and the Economy